Overconfidence and inertia are two ways people go wrong

You might not be able to teach an old dog new tricks, but you might be able to train your brain into doing right by your money.

And that’s especially important for retirees who, according to the editors of a soon-to-be published book about investor behavior, reveal many mental mistakes and emotional issues that influence their decision-making processes.

Train Your Brain

“Although retirees cannot avoid all behavioral mistakes, people can reduce their effects,” wrote H. Kent Baker, professor at the Kogod School of Business at American University in Washington, D.C. and Victor Ricciardi, an assistant professor at Goucher College in Baltimore.

Some investors often exhibit overconfident behavior resulting in overtrading of their portfolios, say Baker and Ricciardi, the latter of whom is also the coordinator of Behavioral and Experimental Research for the Social Science Research Network.

Other retirees suffer from inertia and under-manage their investments.

“A compromise would be to create a solid approach between these two biases,” they wrote.

Trust and Control

Retirees need to create a balance between trust and control in the relationship between themselves and their financial planner, wrote Baker and Ricciardi. “Retirees who place too much trust in financial experts or relinquish control about financial decisions can suffer. The Bernie Madoff scandal is an example,” they said.

Yet, retirees who lack trust or are overly controlling are unlikely to accept the advice of a financial planner, they added.

Worry

Retirees who take too much risk by not diversifying their portfolios often experience high levels of worry. “If they can’t sleep because of their anxiety about their risky investments, they should consider rebalancing their portfolios to contain more conservative asset classes,” Baker and Ricciardi wrote.

Lack of Self-Control

People often lack self-control and prefer spending money today rather than saving for the future by, say, investing in an annuity.

“To potentially overcome this situation, they can reframe the issue,” Baker and Ricciardi wrote. “That is, retirement savers can frame the annuity decision as a source of funds they can spend for playing golf or taking a vacation when they retire.”

Age and Financial Literacy

As individuals enter their 60s, their financial literacy and cognitive decision-making often starts to slowly decline. “Retirees can use aspects of financial planning that cope with the aging process in later years to ensure they can maintain their investments and avoid financial scams,” Baker and Ricciardi wrote. “Evidence suggests that older adults make more financial mistakes than middle-aged adults.”

5 Rules to Stay on Track

So what should retirees do (or not do) with their investments, given the findings in Baker and Ricciardi’s book? Here’s what they had to say:

1. Don’t ignore the detrimental effects of inflation on fixed income and financial assets. For example, as inflation increases, the required rate of return on bonds increases, resulting in a decrease in bond pricees.

3. Don't chase past performance. Mutual funds attract investors by increasing their advertising on high-performing funds. Using past performance as a strategy rarely works. Thus, retirees should avoid jumping on the bandwagon and following the herd.